Removing the Advertising Ban in Rule 506 Offerings

Rule 506(c) of Regulation D, enacted under the Jumpstart Our Business Startups Act (the “JOBS Act”) is intended to help smaller and emerging growth companies raise capital in the U.S. capital markets. The JOBS Act adds new sections to the Securities Act of 1933 (the “1933 Act”) and the Securities Exchange Act of 1934 (the “1934 Act”). The JOBS Act’s stated purpose is to assist small companies in raising capital. Less stringent requirements will encourage smaller companies seeking to raise capital to go public directly, without involving an underwriter, as traditional IPOs do.

In furtherance of this purpose, Section 201 of the JOBS Act requires the SEC to change regulations applicable to Rule 506 Attorneys of Regulation D of the Securities Act. Most notably, the JOBS Act removes the prohibition on general solicitation and advertisement by issuers that rely on Rule 506. Rule 506 is an exemption frequently used by private companies that go public directly on OTC Markets, and by hedge funds, private equity funds and venture capital funds.

The JOBS Act instructs the SEC to write implementation rules, but the SEC has not yet done so. The Act was signed into law on April 5, 2012; the SEC has already missed a 90-day deadline to implement the rules. The commission voted in August to eliminate the ban on general solicitation but the Commission has not yet finalized the rules following a month-long comment period.

Under the JOBS Act, issuers are required to take reasonable steps to verify that purchasers in Rule 506 offerings are accredited investors. The Act significantly impacts the securities laws affecting private companies that go public directly, as well as those who use traditional IPOs.

Rule 506

Currently, Rule 502(c) prohibits a company offering or selling securities in a private placement, or any person acting on its behalf, from using any form of general solicitation or advertising, including any ad, article, or notice published in any newspaper or magazine, on television, or over the radio.

The elimination of the ban on general solicitation in Rule 506 offerings will expand the way companies that go public directly raise capital. Additionally, allowing the advertisement of Rule 506 offerings will also lighten the burden for these companies by making it easier for them to obtain the number of shareholders required to get a trading symbol.

Securities Intermediaries and Portals

The JOBS Act provides that persons who maintain a platform or portal for advertisements in Rule 506 offerings made to accredited investors are not required to register as broker-dealers as long as they are not compensated in connection with the purchase or sale of a security and do not have possession of customer funds or securities.

Go Public Direct Turnkey Solution

Private companies that go public directly typically file a registration statement with the SEC under the 1933 Act. Once the registration statement is declared effective, the company will be subject to the SEC’s reporting requirements, but it will not have a ticker symbol. In order to receive a trading symbol, the company must comply with the requirements of the Financial Industry Regulatory Authority (“FINRA”) which includes demonstrating there will be an active market for the company’s securities. The only way to demonstrate an active market can be established is for the company to have a meaningful shareholder base, which is defined as at least 25 individuals or entities. For private companies seeking to go public, attracting shareholders, like raising capital, can be a challenge.

The elimination of the ban on general solicitation and advertising in Rule 506 offerings will provide private companies with the opportunity to raise capital and obtain the initial shareholder base required by FINRA for ticker symbol assignment. Easing the burden of obtaining shareholders will simplify the process of going public directly and will reduce the number of private companies that go public in risky reverse merger transactions. The bottom line is that the JOBS Act will reduce reverse merger transactions because private companies seeking to go public will have a more time and cost effective method achieving public company status.